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BusinessDay www.businessday.co.za Tuesday 17 August 2021
INSIGHTS
OFFSHORE INVESTMENT Sponsored content
Offshore options allow for ‘Inflation risks are fully priced into markets’; portfolio enhancement Fed seems in control
Look for the •highest returns
with the lowest risk, writes Lynette Dicey
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he unrest that devastated KwaZuluNatal and parts of Gauteng in July jeopardised SA’s fragile economic recovery and put the issue of offshore investing firmly back on the agenda for those with disposable assets. SA’s post pandemic economic recovery is a delicate one at best, particularly compared to the economies of more developed countries. “It’s a muted recovery off a low base,” says Stephen Katzenellenbogen, Private Wealth manager at NFB Private Wealth Management. “Although bullish commodity prices and a post-Covid-19 global recovery have been short-term tail winds for the economy, these tail winds will start to slow down as commodity prices cool off. The reality then facing SA over the longer term is a downward debt trajectory unless there are deep, meaningful and sustainable economic reforms.”
Reyneke van Wyk … consistent. Achieving inclusive economic growth, he adds, is becoming increasingly difficult given how challenging it has become to do business in SA and the extent to which regulatory reform has lagged. Economic growth requires faster reform and real spending cuts. A failure to achieve this is likely to result in lower credit ratings. Given this rather dismal picture, investors can be forgiven for being emotionally charged. Despite this, he insists the decision to invest offshore should always be driven by a sound investment rationale, principles and strategies rather than emotion, which all too often tends to be irrational and poorly thought through. The primary reason why investors should consider investing offshore is because they can enhance their portfolio through diversification and get
access to much broader and deeper markets than are available locally, he explains. “The local equity market is relatively small on a global scale. It does not fairly represent a globally diversified portfolio. Ideally, an offshore investment portfolio should be exposed to a broad set of sectors and subsectors with all investments allocated to areas with the highest possible returns accompanied by the lowest possible risk.” Diversification also offers a second degree benefit of diversifying away from country and currency concerns, he adds. “Many local investors want to be protected against poor local economic policy which may push the country over the fiscal cliff, cause a spike in inflation and interest rates, and result in a weakening of the rand.” The risk return characteristics of a diversified portfolio are clearly positive and support less volatility and better long-term returns. When is a “good time” to buy foreign currency? He says although currency forecasting is far from an exact science, it does provide a valuable point of departure for any deliberations. “There is an expectation that the rand will depreciate at about 1% per year for the next decade. In particular, it will depreciate against currencies supported by
Tamryn Lamb … strategies. a lower inflation rate. Looking at the long-term trend of the rand versus the US dollar, the former’s long-term depreciation is equal to roughly the difference between the US and South African inflation rate.” This means the timing of a foreign currency purchase becomes less relevant given the rand’s long-term depreciation trajectory. “As long as you can avoid buying at an extreme low, the purchase price and timing becomes less relevant, particularly if the plan is to regularly externalise money which will allow you to end up rand-cost averaging.” Reyneke van Wyk, head of Investment Management at Stonehage Fleming SA, agrees that trying to time the currency when investing offshore is not a good idea. “We recommend following a disciplined and consistent approach year after
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year. A phased approach over a targeted time period should reduce exposure to a single currency level and also reduce the risk of emotional investment decisions,” he says. When investing offshore, says Van Wyk, it’s important investors are not doing so for the currency depreciation alone, but rather for the right primary reasons, which include risk diversification and access to opportunities not available in SA. “Long-term devaluation of the rand as a structurally weak currency should be a secondary reason. Be careful of not following the herd, and avoid investing capital that might be required in the short to medium term,” he says. Tamryn Lamb, head of Retail Distribution, Orbis Client Servicing at Allan Gray, agrees that emotion should not influence your thinking. “As South Africans we tend to shift quickly between pride and despair, feeling both in equal measures,” she says. “Decisions regarding how much to invest offshore versus onshore tend to get swept up in this rollercoaster so it’s no wonder investors struggle to adopt and stick to long-term strategies.” Her advice? “Make sure you aren’t buying two houses on the same street and that your portfolio is ‘travelling’ more frequently than you are.”
Central bank liquidity provision has been a primary driver of financial markets over the past 15 months, with major central banks having created more than $10-trillion, creating concerns around inflation risks. “The prevailing narrative is that the US Federal Reserve has lost its inflation discipline and is determined the ‘run the economy hot’,” says Philip Saunders, co-head of MultiAsset Growth at Ninety One. Central banks, he explains, have generally viewed higher inflation as transitory with their focus being on offsetting the potentially depressionary plunge in demand. The market, however, is concerned we may be witnessing a structural shift in inflation which is being entrenched by ultra-loose monetary policies. Short-term concerns around inflation, maintains Saunders, appear overdone. “US breakeven inflation rates have already risen substantially to reflect a higher long-term
THE POST-COVID ECONOMIC RECOVERY HAS BEEN FAR MORE DRAMATIC THAN MOST MARKET PARTICIPANTS EXPECTED
Philip Saunders … wake-up call. inflation outcome than the Fed’s target rate. The consensus is arguably conflating short- and longer-term inflations.” He believes headline inflation numbers will not flip to surprise positively over the balance of the year as the base effects fall away. The debate however, is likely to continue to rage. “The idea that the Fed has given up on its target of anchoring inflation expectations on average around 2% and that, as a consequence, we have entered a world of perpetual dollar debasement, is highly questionable,” says Saunders. While expectations are that inflation will move higher than it did in the post global financial crisis period, he predicts it’s unlikely that we will move back to the high inflation world of the 1970s.
“For now we believe inflation risks are fully priced into markets — at least on a medium-term basis — and it does not appear the Fed will lose control as it seemed to do in the ‘taper tantrum’ of 2012/13,” he says. The post-Covid economic recovery, he adds, has been far more dramatic than most market participants expected, taking even the Fed by surprise. “The recovery — which is set to continue over the next 12 months — including a rosy growth outlook and higher inflation projections have sparked a more hawkish tone from the Fed, bringing the prospect of tapering closer. The Fed is likely to release details on how it intends to curb its bond purchases as early as September. US yields are likely to rise from here with implications for asset markets.” The Fed, he reveals, has signalled there may be at least two interest rate hikes in 2023, much sooner than expected. “This comes as a wake-up call to investors who are in danger of becoming addicted to liquidity. Investors need to pay close attention to policy and policy shifts. Credit spreads are again at historically low levels and equity market valuations are elevated, leaving markets potentially more vulnerable to bad news.”
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BusinessDay www.businessday.co.za Tuesday 17 August 2021
INSIGHTS: OFFSHORE INVESTMENT
It’s about more than investment returns
Through •offshore markets,
Ultra-high net worth individuals (UHNWIs) can apply to take out more than R10m a year if they submit a special concession application to Sars and the Reserve Bank, he says. “A tax clearance certificate, in the prescribed format, must always accompany the application, and the individual needs to ensure their tax affairs are 100% in order.”
local investors can access a world of growth opportunities
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s the world continues to grow into a global network, so too do the global tax laws applicable to investors’ worldwide assets. Even though the world has become more integrated, failing to carefully consider the tax implications of where one invests has the potential to create unnecessary costs and expenses for the investor and their heirs, says Wayne Sorour, head of Sales and Distribution at Old Mutual International. “It makes sense for South Africans to invest a portion of their wealth offshore and take advantage of the benefits of diversification,” he says, adding that the primary benefit is the diversification associated with investing in global asset classes. “The role of an investment portfolio is to reduce risk, which is particularly relevant when the assets out- or underperform at different points in the market cycle. But more than this, in offshore markets investors have access to markets and sectors which are either simply not available in SA or provide more choice through which South
ESTATE CONSIDERATIONS Wayne Sorour … reduce risk. African investors can access a world of growth opportunities.” Ultimately, he adds, the purpose of investing offshore is to reduce the concentration risk that comes with exposing all your investments to one market. Sorour advises that high net worth individuals (HNWIs) should take their annual allowance of R10m offshore. “Although Sars and Reserve Bank clearance are required for this amount, the benefit is it can be done every year and there is no lifetime limit. What this means is over a 10-year period an individual could invest R110m offshore or R220m as a couple.” He explains that investors can also use their discretionary R1m a year, which requires no clearance, to get that diversification and exposure. “Money externalised in this way never has to be repatriated. It can be invested offshore or kept in a bank account for use when travelling or to educate South African children abroad.”
Before deciding to invest offshore, potential investors should consider the estate planning implications. “Many people simply look for the best returns — but tax and inheritance issues are equally important,” he stresses, adding that it’s a good idea to factor in the legal mechanisms which make offshore investing easier, with beneficiaries being nominated to inherit the assets abroad. “Jurisdictions such as the US and UK are increasingly eyeing the estates of noncitizens investing in certain assets physically situated within their jurisdiction,” says Sorour, explaining that this is called the situs tax. On death, South African residents are liable for estate duty based on their worldwide assets. Estate duty is currently levied at a rate of 20% in the case of an estate less than R30m, and at a rate of 25% on the value above R30m. However, both the UK and the US also levy an estate duty on certain situs assets. In the UK this is known as inheritance tax
and in the US it’s called estate tax. Collectively, they are known as situs taxes. “In the UK, a 40% inheritance tax will be levied on situs assets, including fixed property, over the value of £325,000. Any amount falling below the £325,000 threshold is known as the ‘nil rate band’ and is free from situs tax. Each individual receives this £325,000 exemption. In the US, the threshold for estate tax is much lower at only $60,000. The top bracket for estate tax is 40% on US situs assets. In contrast to the UK, the US offers no spousal exemptions or rollovers unless the spouse is a US citizen.” In SA HNWIs may be liable for 20% SA estate duty, as well as a potential 40% situs tax on their US and UK situs assets, he explains. “Although there are double taxation agreements in place, this would still result in a net tax of 40% instead of the 20% estate duty payable in SA.”
ASSET SWAPS
One of the primary motivations for taking capital offshore is to ensure access to capital abroad. “If an investor’s sole interest is the offshore return — as in the case of a pension fund — then an asset swap mechanism is the preferred vehicle,” says Sorour. The major difference between capital physically taken abroad, and capital using an asset swap mechanism, is that in the case of the latter the money ultimately must be repatriated having earned offshore returns in the interim. Asset swaps are more
Compelling reasons to be looking offshore convenient for smaller amounts where there is little point in going to the effort of going through Sars and being audited. “We focus primarily on the direct route at Old Mutual International, but we can access asset swap capability through relationships we have with several investment houses which don’t use their full capability,” he says. With an asset swap, an investor buys a randdenominated unit trust through a South African financial institution. The unit trust company then uses its asset swap capability to invest the funds offshore. The investment returns are repatriated and paid out in rands. Asset swaps are ideal for investors who don’t need to physically move their funds offshore but would still like to profit from investing in overseas markets. Says Sorour: “Investing offshore needs to be tailored to investors’ needs. To find the right fit, investors need to evaluate different scenarios in terms of their investment goals — and this should be done with the assistance of a financial planner to customise a unique plan for their lifestyle.”
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While the rand continues to trade at well below R15 to the US dollar, ostensibly providing investors with an attractive entry point to offshore markets, currency valuations are only one consideration. Investors still need to be selective in their approach given valuation and financial planning risks. In fact, says Paul Hutchinson, sales manager at Ninety One, when deciding to invest in offshore assets, investors need to take a longer-term view and look past the shorter-term movements of the currency. That being said, there are a number of compelling reasons for South Africans to be investing offshore. These include diversification benefits to provide access to a much wider range of investment opportunities to grow the investor’s money across countries, industries, companies and currencies; reduced emerging market and South African specific risk, including reducing currency risk; and the maintenance of “hard currency” spending power, he explains. But having made the decision to invest offshore is only the first step. Exactly how much should be investing offshore? “The short answer is it depends on each investor’s personal circumstances, risk profile and longer-term financial planning objectives,” says Hutchinson, adding that all investors can benefit from a meaningful offshore allocation. Studies recommend a minimum strategic allocation of at least 30% for long-term investors targeting inflation plus returns to ensure a comfortable
Paul Hutchinson … wider range. retirement. For those targeting inflation plus 6% and more the required offshore allocation rises to above 40%. Pensioners, on the other hand, have a specific portfolio requirement given that they require a monthly income in retirement. “Our research indicates that a living annuity typically requires a consistent 20% to 40% exposure to offshore equities, irrespective of the level of starting income,” says Hutchinson. Wealthier investors who don’t require an income to match any South African liabilities are able to invest significantly more offshore — up to 100% — depending on their objectives and tolerance for risk, he reveals. However, he points out that while global equities have outperformed South African equities over the past 10 years — which would seem to warrant a 100% offshore allocation — this relative outperformance is cyclical. Hutchinson says the reality is that most investors need to invest more offshore than the somewhat arbitrary 30%
allowed in terms of Regulation 28 of the Pension Funds Act. Given the lack of proximity to international markets and asset managers — and the sheer number of funds from which to choose — most local investors looking for offshore exposure tend to gravitate towards multiasset funds. Hutchinson suggests looking to global equities or high-equity global multi-asset solutions with longterm track records that have proven their mettle through investment cycles. But exactly how many funds should be included in an ideal portfolio blend? Research indicates that diversification benefits are limited beyond a small number of funds, explains Siobhan Simpson, sales manager at Ninety One.
ZERO CORRELATION
She reveals that the riskreducing benefit of adding more than four funds to a portfolio dissipates because most funds have some degree of correlation. “The Holy Grail is to find funds that have zero correlation. Only if you can find funds with zero correlation can you consider blending six or more funds.” There is no question that optimising offshore portfolios results in reduced portfolio risk. “Our research demonstrates that adding an appropriate sector, regional or style tilt could add additional returns to a portfolio,” says Simpson. However, given the complexity and importance of fund selection divisions, professional financial advice, tailored to an investor’s individual circumstances is a good idea, she concludes.
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BusinessDay www.businessday.co.za Tuesday 17 August 2021
INTERNATIONAL BUSINESS
Insurers seek new risk models Key Chinese port closed for sixth day as natural disasters balloon after Covid-19 case CONTAINER TERMINAL
• The industry is scrambling to keep up as snowstorms, hail, tornados and wildfires start to take an ever-higher toll Leslie Kaufman
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f you are having trouble wrapping your mind around the spree of natural catastrophes plaguing the world — from deadly July floods in Germany and China to the wildfires still burning in Greece, California and Siberia — you may be interested to know the professional risk calculators are too. Climate change is worsening extreme and freak weather events so rapidly that even the insurance industry is struggling to keep up. Late last week, reinsurance giant Swiss Re released its midyear insurance losses and the figures were the secondhighest on record. Insurers had to cover $40bn in losses caused by natural catastrophes. The 10year average for the first half of the year is $33bn. The insurance losses increased even though total economic losses from the natural disasters that they were based on actually decreased to $74bn, down 31% from the year before. Martin Bertogg, head of catastrophic perils at Swiss Re, said the industry had been challenged by what is known as
THE SAFEST BET WHEN THE CLIMATE IS CHANGING IS THAT WEIRD THINGS ARE GOING TO HAPPEN
“secondary perils”. While the insurance industry historically has done a good job of modelling relatively rare but potentially devastating events such as earthquakes and hurricanes, it is battling to keep up with risks posed by snowstorms, hail, tornados and wildfire. These used to cause relatively minor damage but are increasingly morphing into something more costly. And that is a problem for companies in the US especially, since many Americans have coverage for such events. Winter Storm Uri, which pounded Texas in February with snow and subfreezing temperatures, is a good example. Uri caused $15bn in losses, making it the largest loss from a winter event in US history, Swiss Re said. While the jury is still out on whether climate change is directly to blame for Uri — the idea that warming makes the polar vortex unstable is not conclusive — the safest bet when the climate is changing is that weird things are going to happen a lot more. Severe weather, including hail and tornadoes in Central Europe in June, accounted for about $4.5bn in losses and have been linked to climate change. Swiss Re thinks this type of event is a trend it needs to get on top of. “The insurance industry needs to upscale its risk assessment capabilities for these lesser monitored perils to maintain and expand its contribution to financial resilience,” Bertogg said in its
Under water: Collapsed houses in a floodaffected area following heavy rainfalls in Schuld, Germany, in July. Losses from the floods may be as much as $6.5bn, Swiss Re estimates. /Reuters/File
report on the losses. That is easier said than done, said Erdem Karaca, who oversees catastrophic perils in the Americas for Swiss Re. “Models are less mature for secondary perils,” he said. “A peril like wildfire is also impacted by humans — 90% of ignitions are caused by humans, so it is difficult to quantify through models.”
Still, the industry is determined to get better. Over recent years modellers have become much more sophisticated at predicting flood risk, Karaca said. In the US, more sophisticated flood modelling has caused the Federal Emergency Management Agency, which handles 95% of residential flood insurance, to initiate its first new flood-rate model in 50 years.
Private insurance companies are also racing to deploy better models for fire prediction. For many people, better information will translate into higher premiums. In the meantime, catastrophic weather keeps coming. Losses from Germany’s floods are not counted in this recent report, which covered January to June. They may be as much as
$6.5bn, Swiss Re estimated. And hurricane season has hardly hit its peak; in the northern hemisphere that comes in the third quarter of the year. Tropical Storm Fred, which is passing over the Florida Panhandle, is expected to do comparatively little damage. But Grace and other storms are on their way, and losses are sure to mount. /Bloomberg
Terminal illness: There are concerns that more ports across the world could become disrupted by the Delta variant. /Reuters/File Agency Staff China’s Ningbo-Zhoushan container port, the world’s third busiest, remained partially closed for a sixth day on Monday amid ongoing concern over whether the shutdown will disrupt trade from the region in the longer term. The port has not published any updates on its operations since Wednesday, when it halted all inbound and outbound container services at its Meishan terminal after one employee tested positive for Covid-19. Consultant GardaWorld estimated the terminal accounted for about 25% of container cargo through the port, though Ningbo-Zhoushan had said it would redirect ships to other terminals and adjust operating hours at other docks. An employee at the port’s media centre said they had no new information to share when contacted by Bloomberg News on Monday. No new infections had been reported at the port since the initial case. Shipping firm Yang Ming Marine Transport Corporation warned clients of potential “port congestion” due to the partial
closure in an advisory on Monday, while Orient Overseas Container Line has reminded customers to check terminals before arranging for their containers to be sent to Ningbo. Maersk said on Friday it was having vessels on services between Asia and South America call at the Meishan terminal, and that all would omit Ningbo in August. Yards at Beilun and Yongzhou terminals were up to 79% full with laden containers and as much as 85% for empty boxes, Maersk said on Monday. Since bringing the initial coronavirus outbreak in Wuhan under control in 2020, China has taken a zero-tolerance approach to Covid-19, taking strict measures to quash even single cases. The latest port disruption followed the closure for about a month of Shenzhen’s Yantian port in late May after an outbreak among port staff. It also stoked fears that ports around the world could face similar outbreaks given the spread of the highly infectious Delta variant, potentially triggering the sorts of disruptions that affected global shipping in 2020. /Bloomberg
INSIGHTS: OFFSHORE INVESTMENT
Positioning offshore portfolios for the fading of the reflation trade Both the local and global economies are likely to face a bumpy road ahead which is why investors need to focus on a portfolio of high-quality, diversified, multinational companies with robust balance sheets and track records of delivering increasing dividend streams, says chief investment officer at Marriot Investment Managers, Duggan Matthews. The past 16 months, he says, have represented an interesting but uncertain time in global markets. “As a number of major economies started to emerge from the pandemic, the first quarter of 2021 was all about ‘reflation’ — a belief that huge fiscal stimulus, historically low interest rates and the reopening of economies following Covid19 vaccinations would drive an economic boom placing upward pressure on inflation.” Although a strong recovery in global GDP growth and a pick-up in inflation in 2021 is expected, he does not expect these inflationary pressures will be sustained. This expectation is driven by four core considerations. First, the annual inflation statistics over the coming months will be distorted by the disinflation which occurred in many economies in March and April 2020 as Covid-19 took hold. However, says Matthews, these base effects are transitory and do not indicate longer term inflationary pressures. Second, it’s expected there will be some supply chain bottlenecks which will cause temporary upwards inflation pressure, but these will reduce over time as the bottlenecks clear. Third, expect an uneven global recovery. Matthews points out that the IMF, despite increasing global growth projections in April this year, has noted that while China had already returned to pre-Covid GDP in 2020, many other countries, including SA, are not
Duggan Matthews … think global. expected to do so until well into 2023. This will act to curtail global inflation. The fourth consideration centres around global debt levels. “The underlying health of the global economy has a major influence on how quickly it can recover from shocks. One concern is the relatively high amount of debt that was held prior to the pandemic and which has subsequently been increased by fiscal stimulus measures. The IMF notes, for example, that public debt-to-
GDP of advanced economies was 105% in 2019, in contrast to 72% before the 2008/9 financial crisis. This debt burden will likely prove deflationary in the years ahead.” Given that US 10-year bond yields have recently fallen to 1.2%, Matthews says it appears the market is less concerned about inflation and agrees with the Federal Reserve that inflation in the US will settle close to the its average target, but is more concerned with growth. He says investors should consider positioning their portfolio for the inevitable fading of the “reflation trade” as the market comes to realise the global economy will continue to face challenges. “Diversified, multinational companies with robust balance sheets tend to be less volatile and more resilient, making them more predictable and less likely to come under pressure in the months and years ahead if growth and inflation don’t live up to the elevated expectations currently being priced into the market,” he says. Investors should be looking at companies that are market
29%
the year-onyear increase enjoyed in the first quarter of 2021 by the American company Texas Instruments, which is ideally positioned to benefit from the global chip shortage
/123RF — RAFAELBENARI
leaders with strong brands and pricing power, have robust balance sheets and cash flows, and produce goods or services that are integral to the lives of their customers, he says. “These qualities enable them to perform well in an inflationary environment and when times are tough.” Companies such as Procter & Gamble, for example, have continued to deliver strong revenue and earnings growth throughout the pandemic by selling a diversified range of consumer goods around the world. Their recent dividend increase was their 65th consecutive increase in annual dividends, says Matthews. Microsoft is another business that has successfully navigated the pandemic and benefited from an accelerated digital transformation, he says, adding that the business has flourished in the past year. Another good example of a company that has continued to perform well is Texas Instruments, which has maintained robust profit margins despite coming under pressure in early 2020 during the Chinese lockdown. “This year the company is ideally positioned to benefit from the global chip shortage. Its first quarter revenues increased by 29% year on year,” says Matthews. Investing, he adds, needs to be approached with a global perspective and mindset. Marriott Investment Managers, one of the oldest financial services businesses in the country with more than R34.9bn in assets under management, was acquired by Old Mutual in 2005 and operates as an independent boutique as part of the Old Mutual Investment Group. Its investment style focuses on predictable investment outcomes by applying an income-focused investment style.
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